Gains From Devaluation To Quickly Eroded

BMI View: We are of the view that the devaluations of the dong in November 2009 and February 2010 have done little to address Vietnam's underlying balance-of-payments problems. We are therefore expecting a further devaluation, this time coupled with a tightening of fiscal and monetary policy. This should help Vietnam contain its trade deficit in 2010 to US$12.4bn, or roughly 13.1% of GDP, after an estimated US$12.2bn (13.4%) shortfall in 2009.

We believe that the latest devaluation of the dong, by 3.4% to VND19,100/US$ on February 11, will only have a temporary effect on Vietnam's balance-of-payments. Indeed, the benefits will largely be reaped in the form of the release of foreign currency inflows held up by the expected devaluation increasing the availability of greenbacks in the local market. However, we reiterate that the devaluation will do little to address the fact that domestic demand is still markedly stronger than external demand for Vietnam's key exports. Moreover, accelerating inflation will continue to erode public confidence in the value of the dong, raising pressure for further devaluations.

Indeed, macroeconomic data for December and January support our view that the 3% devaluation effected by the Vietnamese authorities on November 25 would only serve to narrow the trade deficit temporarily. Indeed, the upward revision of the December trade deficit from US$1.3bn to US$1.9bn shows that the improvement from the US$2.1bn shortfall in November was only marginal. The estimates for January saw the trade deficit fall to US$1.3bn on the back of a 16% m-o-m fall in imports to US$6.2bn while exports fell 11% to US$4.9bn. However, we believe these figures may well be revised to reflect a higher trade deficit (as has been the case with trade data releases in Q409) for January.

Inflation And Input Costs To Wipe Out Gains From Devaluation

The cumulated 7.3% devaluation between November 2009 and February 2010 has improved Vietnam's competitive position vis-à-vis China and other rivals. However, we expect these gains to be short-lived as the reduction of labour costs in real terms will be quickly eroded by demands for higher wages as inflation reaches double digit territory. Moreover, the garment and footwear industry, Vietnam's main export items after oil, requires a high degree of imports of fabric and other input goods, the cost of which will not have been affected by the devaluation.

We have not made any change in our export forecast (as it already factored in expected devaluations), which sees overseas shipments increase 13.0% to US$63.9bn in 2010 on the back of an improvement in demand conditions in G3 markets. The Vietnam-Japan Economic Partnership Agreement (VJEPA) has given Vietnamese enterprises increased access to the Japanese market, which should support exports, especially if the Japanese yen maintains its recent strength. This should mitigate the more troubled outlook for shipments to Europe and the US.

Our import forecast for 2010 stands at US$76.3bn, 10.9% up from an estimated US$68.8bn in 2010. However, this forecast assumes that the Vietnamese government will embark on a fairly sharp tightening of fiscal and monetary policy during the year, taking the base rate to 12.00% and reducing the fiscal deficit (including off-budget spending) from an estimated 8.9% of GDP in 2009 to 6.2% in 2010.

A failure to sufficiently tighten monetary policy, or indeed a delay in doing so, poses upside risks to our forecast of a US$12.4bn trade deficit in 2010, marginally higher than the US$12.2bn shortfall estimated in 2009. In GDP terms the trade shortfall is projected to fall from 13.3% in 2009 to 13.1% in 2010. We expect the domestic policy tightening to gain more traction in 2011, at the same time as global economic growth rises from 2.9% to 3.2%. This positive dynamic should see the trade deficit remain stable in dollar terms (US$12.3bn compared to US$12.4bn), but fall to 11.6% of GDP.

The devaluation should have a stronger effect on the services export component of the balance of payments. We are expecting service exports to rise by 15% in 2010 to US$7.1bn on the back of a recovery of the tourism sector as Vietnam's allure as a cheaper alternative to Thailand gets a boost from the devaluations of the dong and the recent strength of the Thai baht. Conversely, the weaker dong should hold back service imports. We expect the service trade deficit to decrease to US$1.3bn in 2010 from an estimated US$1.5bn in 2009 and US$2.3bn in 2008.

Remittances Resilient, Risk From Housing Market

Remittances from abroad have proved fairly resilient through the global downturn on spite of Vietnamese workers being laid off in Taiwan and other regional economies. We have estimated that remittances fell 7.7% in 2009 to US$6.3bn, from US$6.8bn in 2008 with the resurgence in the housing market in the latter part of the year drawing in inflows from overseas Vietnamese. We expect remittances to increase by 11.2% in 2010 to US$7.0bn on the back of a continued rebound in global economic growth. Moreover, government policies aimed at encouraging overseas Vietnamese to invest in the Vietnamese housing market should add to the remittance inflows. However, we see a risk that a protracted slump in the housing market, which is not our core scenario, could have a dampening effect on remittances.

We expect the resilience in remittance inflows to be a key factor in driving down the current account deficit, in spite of the upward pressure they add to import demand. We are forecasting the current account deficit to fall to US$8.3bn in 2010, 8.7% of GDP, from an estimated US$9.2bn in 2009, 10.1% of GDP. For 2011, we see the current account deficit at US$7.9bn, or 7.4% of GDP. This is still a sizeable shortfall and is, together with the large fiscal deficit, a key factor in Vietnam's poor score of 44.0 in our short-term economic risk rating. However, while we recognise the risks, we do not expect Vietnam to fall prey to the same market pressure as for instance Greece, another high twin deficit country, has in recent months.

This is primarily because Vietnam's external debt position is highly secure ( see 'Limited Risks To External Debt Position', February 4 2010). In addition, the far-reaching capital controls in the Vietnamese market, which is virtually off-limits for international investors without a presence in the country, eliminates the risk of capital flight.

We expect the outflow in Vietnam's current account to be covered by inflows in the capital and financial account. Vietnam raised US$1bn in a foreign bond issue in January and has secured financing from multilaterals such as the Asian Development Bank and the World Bank and bilateral donors such as France and Japan. As a consequence, we see no greater risks for Vietnam's balance-of-payments even if foreign direct investment inflows were to be stalled due to continued uncertainties about the economic policy and the value of the dong. We expect Vietnam's foreign exchange reserves to rise from an estimated US$15.5bn at the end of 2009 to US$17.5bn by end 2010, approximately 2.8 months of imports.